Financial Discussions

The Engulfing Pattern is a Japanese candlestick pattern that appears after a bull rally or a steep decline. It signals a trend reversal by shocking the trend with a sudden opposite movement. The Engulfing pattern involves two candlesticks; in general, the more candlesticks that are involved in a pattern, the more powerful it tends to be. Below are some sample pictures of what an Engulfing pattern looks like when charted.

As you can see, the first day of a bearish engulfing pattern is an up day. Then in the second day, a large upward gap is undone as the candle drops below the first day’s opening price. The same thing is true for the bullish version, except that it occurs during a bear rally instead.This pattern is made stronger or weaker by several factors.

1. High volume on the second day of the pattern strengthens the pattern.

2. A small real body on the first day and large real body on the second day strengthens the pattern.

3.When the engulfing pattern appears after fast (as in steep) or extended (as in long lasting) trend, it is strengthened.

Below is a chart showing the engulfing pattern amongst other candlesticks.

The engulfing pattern can also be used to set stops and to identify areas of resistance in price. The diagram below shows exactly where to place support, resistance, and stops for all types of engulfing patterns.

The engulfing pattern requires no confirmation. As soon as the pattern is complete, it validates the trade. However, it is important that you keep in mind where your stop loss is and how much you stand to lose if the trade goes sour. Proper money management is a trait all successful traders share.

All pictures are credited to Steve Nison, author of Japanese Candlestick Charting Techniques 2nd Ed.